WITH
FORGED ENDORSEMENTS by
Jeffrey F. Sax, Esq.1 Recently I was
confronted with an unusual case involving forged
endorsements of company checks. It took me to the two
largest banking centers of the United States. Some of the
names have been changed to avoid whatever implications using
real names would entail; however, all of the facts described
below are real. A. Factual
Scenario Ron, about to take
the deposition of a witness he needed to tear apart to make
his client’s case, waited in his friend’s
conference room. The court reporter was at the end of the
table to his left. The videographer was directly behind him.
The witness, Benny, entered the room with his lawyer. Benny
sat down across from Ron, unbuttoned his coat, and revealed
a large caliber pistol sitting snugly in a shoulder holster.
Ron concealed his surprise and disconcertment. “Can you
please put your gun away,” he asked
politely. “I don’t
feel comfortable with that,” came the reply. “You know
it’s illegal,” ventured Ron. “I have a
license to carry it,” Benny responded. “Will you put
it away,” Ron asked more firmly. “No.” Ron contemplated
his dilemma. Sitting in his friend’s downtown Manhattan
high rise office was a thug whose credibility needed to be
destroyed. Running to court for a protective order would
surely succeed, but it would be expensive, especially since
his California client paid for his travel across the county
to take this man’s testimony. Ron represented a
small but very successful pharmacy in Beverly Hills owned by
Paul. Benny owned a check cashing store in the Bronx. Paul
had written 13 checks for $50,000 each to his pharmaceutical
company supplier, Cardinal Health. The checks were made
payable to “Cardinal” and given to the office
manager, Ray, for mailing. Several weeks later, Cardinal
Health inquired about payment. Paul investigated and learned
that a “Robert Cardinal” had presented the checks
for payment at Benny’s check cashing store in the
Bronx, 3,000 miles away. Benny had cashed the checks without
calling Paul for verification. By then, Ray had quit as the
office manager and his whereabouts were unknown. Paul’s
accounts were at Bank of America in California and were
short by $650,000. Benny’s accounts were at a bank in
New York called North Fork Bank. Paul demanded that Bank of
America reimburse him for paying on checks with a forged
endorsement. Bank of America made the same demand upon North
Fork Bank, who had allowed Benny to negotiate the checks and
deposit the funds into Benny’s account. North Fork Bank
froze the funds in Benny’s account. Benny sued
everybody in the chain of the transactions: Bank of America,
North Fork Bank, and Paul. So Ron, sitting in
a comfortable office facing off with a fully armed Benny who
held $650,000 of Paul’s money, made a decision.
“Swear in the witness,” he instructed the court
reporter. The bank’s
lawyers were also there, waiting for the kill. But Ron had
the first shot at Benny and he was prepared. The banking
laws of California and New York were both in play and the
answers were far from clear. Benny’s testimony could be
determinative of which bank was responsible, or whether Paul
would bear the loss. B. Choice of Law
Issues It was not yet
decided whether New York or California law would control.
The liability of a bank for action or non-action with
respect to any item handled by it for purposes of
presentment, payment or collection is governed by the law of
the place where the bank is located.2 Courts have
used this principle to apply the law of the state where the
branch that performed the act is located. If the bank branch
is in New York, New York law applies.3 However,
Benny’s check cashing business might not be a
“bank” under either California or New York law.
Both the New York UCC and the California Commercial Code
define a “bank” as “any person engaged in the
business of banking”4 but provide no
definition of the phrase “the business of
banking.” Ron’s research uncovered no case that
addressed the issue of whether a check cashing service may
be deemed to be a “bank” within the meaning of the
UCC.5 If UCC banking
provisions were inapplicable in determining which law
applies to the rights and liabilities of Benny’s
business, issues regarding the choice of law would probably
be governed by the UCC’s more general choice of law
provision. Both the New York and California use the same
vague standard – “the transaction must bear an
appropriate relation to this state.”6 New
York courts have held that a court should examine the
“grouping of contacts” or “center of
gravity” by determining which state bears the
“most significant relationship” to the
controversy.7 California courts adhere to the
“governmental interest” approach, the objective of
which is to determine the law that most appropriately
applies to the issue involved.8 Ron knew that
strong arguments could be made for either New York or
California under these circumstances. C. Analysis of
Claims and Defenses With respect to the
transactions involving the stolen checks, North Fork Bank
was the “collecting bank” or “depositary
bank” and Bank of America was the “payor
bank” or “drawee bank.”9 It was
not clear to Ron, however, whether Benny’s company, to
which the stolen checks were presented for payment in the
first instance, should also be considered a collecting bank
or depositary bank like North Fork, or was more properly
analyzed as something other than a bank. (i) Claims Against
Benny’s Check Cashing Company Ron believed that
Benny would not be regarded as a depositary or collecting
bank because the persons who negotiated the stolen checks
did not maintain accounts with him. In fact, since no one
maintained accounts with Benny’s company, it would
instead be deemed a “holder” of the checks and not
a collecting bank.10 A bank at which checks are
cashed but not deposited is a holder and not the depository
bank, and therefore, the bank cannot be liable for paying
the checks if it qualifies as a holder in due
course.11 If, however, Benny’s company was
deemed to be equivalent to a depositary bank, then Paul
would probably be precluded from asserting any claims
directly against Benny pursuant to the general rule that a
drawer does not have a direct cause of action against a
depositary bank for collecting an improperly endorsed
check.12 This rule protecting banks applies only
to holders in due course. Indeed, a holder in due course
takes the instrument free from all claims to it on the part
of any person, and subject only to certain specified
defenses which would not be applicable here.13 A
holder in due course is: a holder who takes the instrument
(in this case, each stolen check) (a) for value, (b) in good
faith and (c) without notice that it is overdue or has been
dishonored or of any defense against or claim to it on the
part of any other person.14 direct cause of
action by the drawer against the depositary bank. Noting the
division of California courts on the issue of a drawer's
claim for conversion against a depositary bank, the Ninth
Circuit in Lewis v. Telephone Employees Credit Union, 87
F.3d 1537 (1996) (applying California law) concluded that
the cases finding no such claim had the better of the
argument and ruled that the California Supreme Court would
hold that a drawer does not have a cause of action for
conversion against a collecting or depositary bank; also see
Mills v. U.S. Bank, 166 Cal. App. 4th 871, 886 (2008) for a
competing view. The California Supreme Court has not yet
ruled on the subject. Ron knew that
Benny’s lack of good faith would be the key to
prevailing against him, assuming that Benny was deemed a
bank. “Good faith” means “honesty in
fact” in the conduct or transaction
concerned.15 The existence of bad faith turns on
whether the holder of an instrument knew that the
transaction was suspect.16 Because the inquiry
turns on the holder’s actual knowledge, mere negligence
by the holder in failing to discover suspicious
circumstances does not constitute bad faith.17
Ron also knew that he could prevail if he proved that Benny
took the stolen checks in bad faith or with actual notice of
suspicious circumstances such as fraud.18 Minor
irregularities in a check or misnomers in the name of a
payee on a check do not qualify as visible evidence of
forgery or alteration sufficient to defeat the rights of a
holder in due course because they do not supply notice to
the purchaser of something wrong.19 Applying these
principles, Ron knew that because the Stolen Checks did
appear on their faces to be endorsed by the names to which
they were payable, and there did not appear to have been a
recognizable alteration of any of the endorsements, Benny
would likely prevail if his check cashing company was deemed
a bank. Ron was also
cognizant of the “fictitious payee” rule that
might insulate Benny from liability. The general rule is
that any unauthorized signature on an instrument renders it
inoperative. The fictitious payee rule constitutes a key
exception to that rule.20 If it were demonstrated
that Ray (or another individual signing on behalf of the
Paul’s pharmacy) signed one or more of the stolen
checks without actually intending that Cardinal Health would
have any interest in them, then Benny might not be liable
for cashing them.21 The rationale underpinning
the fictitious payee rule is a policy judgment that an
employer is better suited to bear the risk of its own
faithless employee’s defalcations. The rule expresses a
fundamental public policy determination that losses arising
in the specific manner described by the statute are more
business risks than banking risks. The employer is normally
in a better position than the banks that handle the check to
prevent forgeries by taking reasonable care in the selection
or supervision of its employees, or at least is in a better
position to cover the loss by fidelity
insurance.22 If the fictitious payee rule was
applied here, its effect would likely be to shield Benny
from any claims Paul asserted seeking to hold Benny liable
for acceptance of the stolen checks.23 Because of the
fictitious payee rule, Ron decided not to try to trap Benny
and implicate Ray, regardless of how fervently Paul believed
Ray was responsible. Only by establishing a conspiracy
between Benny and Ray to defraud Paul could Ron defeat the
fictitious payee rule24 and Ron believed that the
chances of him proving it were remote. Ron also had to be
careful because if Benny’s testimony somehow
established that Paul had been negligent in contributing to
the forged signatures on the stolen checks, then Benny could
escape liability simply by Paul’s carelessness. The
rule is simply stated in the UCC. “Any person who by
his negligence substantially contributes to a material
alteration of the instrument or to the making of an
unauthorized signature is precluded from asserting the
alteration or lack of authority against a holder in due
course or against a drawee or other payor who pays the
instrument in good faith and in accordance with the
reasonable commercial standards of the drawee’s or
payor’s business.”25 (ii) Claims Against
North Fork Bank North Fork Bank was
where Benny had deposited the funds from the stolen and
forged checks. Paul understood that as to North Fork Bank,
New York and California law once diverged. In New York, in
general, a drawer does not have a direct cause of action
against a depositary bank (as opposed to a drawee bank) for
collecting an improperly endorsed check.26 In
California, while a drawer once could bring an action
against a collecting bank under a theory of breach of the
warranty of good title,27 the law changed in 1992
and California law now appears to be in accord with New
York.28 So although Benny might have a claim
against North Fork Bank for freezing his funds, Paul held no
such claim. (iii) Claims
Against Bank of America Ron knew that the
claims against Bank of America, Paul’s bank, were
stronger. The general rule is that as between the drawee
bank and the depositor, losses from a forged or unauthorized
signature are borne by the bank since payment not made
pursuant to directions of a properly payable order cannot be
charged to the depositor’s account.29 Bank
of America could take advantage of the fictitious payee
rule; however, California law applies a more favorable
standard to Paul. Rather than a bad faith standard used in
New York, California uses an “ordinary care”
approach.30 Bank of America
could also rely on Paul’s negligence as a defense to
the claim under the California Commercial Code. “For
the purpose of determining the rights and liabilities of a
person who, in good faith, pays an instrument or takes it
for value or for collection, if an employer entrusted an
employee with responsibility with respect to the instrument
and the employee or a person acting in concert with the
employee makes a fraudulent endorsement of the instrument,
the endorsement is effective as the endorsement of the
person to whom the instrument is payable if it is made in
the name of that person. If the person paying the instrument
or taking it for value or for collection fails to exercise
ordinary care in paying or taking the instrument and that
failure contributes to loss resulting from the fraud, the
person bearing the loss may recover from the person failing
to exercise ordinary care to the extent the failure to
exercise ordinary care contributed to the
loss.”31 In summary, the
endorsements on the stolen checks would be deemed to be
“effective” (thereby potentially precluding Paul
from recovery against any person or entity who accepted
them, even though their endorsements were forged) in one of
the following two circumstances: (i) if it were proven that
Ray signed one or more of the stolen checks without actually
intending that they would be delivered to the payee
(Cardinal Health), or (ii) if it were proven that Ray, as an
employee entrusted with responsibility for Paul’s
checks, acted in concert with a person who fraudulently
endorsed one or more of the stolen checks. Simply stated,
the risk of loss for fraudulent endorsement by employees
entrusted with responsibility for checks falls on the
employer rather than the bank that takes the check or pays
it.32 Bank of America
could also defend against Paul based upon a comparative
negligence theory. If Bank of America proved that Paul acted
negligently and that such failure to exercise ordinary care
contributed to the forgery of the endorsement, its liability
to Paul would turn on the evaluation of the relative
negligence as between Bank of America and Paul. Bank of
America would bear the burden, in the first instance, to
prove that Paul failed to exercise ordinary care. If it made
such a showing, Paul would then bear the burden to show that
Bank of America also failed to exercise ordinary care and
that such negligence by Bank of America was sufficient to
offset, at least in part, the effect of Paul’s own
negligence so that Paul could still obtain a recovery from
Bank of America.33 (Under New York law, this
concept of comparative negligence does not
exist.34) Ordinary care in the case of a person
engaged in business means observance of reasonable
commercial standards, prevailing in the area in which the
person is located, with respect to the business in which the
person is engaged.35 In the case of a bank that
takes an instrument for processing for collection or payment
by automated means, reasonable commercial standards do not
require the bank to examine the instrument if the failure to
examine does not violate the bank’s prescribed
procedures and the bank’s procedures do not vary
unreasonably from general banking usage not disapproved by
relevant provisions of the UCC.36 Using these
standards, Ron knew that a contest between Paul and Bank of
America on a comparative negligence basis did not bode well
for Paul. So the key was preventing Bank of America from
proving that Paul was negligent. Without Paul’s
negligence, no comparative negligence analysis came into
play. D.
Conclusion Armed with this
knowledge, Ron began Benny’s deposition. Benny
testified that the checks were cashed on at least five
separate occasions. Because the checks were so large, Benny
himself called Paul’s pharmacy to verify the first
check. He spoke to an employee whose name he could not
recall and was told that the check was “okay.” He
then called Bank of America to verify that there were
sufficient funds in the account. Having received adequate
verification he cashed the check. No other checks from
Paul’s pharmacy were verified because Benny now trusted
Paul’s account. Benny also testified that his practice
was to keep logs of each check that he cashed and what was
done to verify them, but the logs for this time period were
destroyed because of a flood at his store. So Benny had no
documents to back up his story. Benny denied knowing Ray and
claimed his decisions to cash the check were independent.
Benny also denied knowing Paul. However, Benny told a
colorful story about Paul’s ex-wife coming to his store
drunk, yelling at him, and making all sorts of threats and
accusations. After Benny forcibly removed her from the
store, she stayed outside on the streets of the South Bronx
continuing her tirade. Because
Benny’s lawyer was not versant on these complex issues,
Benny was not well prepared for his deposition, and he did
not understand what he needed to say to exculpate himself.
He fell into every trap Ron set. Ron used Benny’s
testimony to support a motion for judgment. Realizing his
predicament as detailed in Ron’s motion, Benny offered
to settle the case. Ron was able to force a settlement with
Benny and recover the value of most of the stolen checks.
Paul also tendered his losses to his business insurer under
his commercial general liability policy. He was forced to
sue the insurer for a bad faith denial of his claim. He
eventually recovered the balance from the insurer, but that
is a story for another day.
1 David
Pourati, Esq. also contributed to this article, ensuring
that all footnoted cites are accurate. 2
Section 4-102 of the Uniform Commercial Code
(“UCC”), embodied in Section 4-102 of New
York’s UCC and Section 4102 of California’s
Commercial Code. 3 See,
e.g., Adamar of N.J., Inc. v. Chase Lincoln First Bank, N.A.
201 A.D.2d 174, 176, 615 N.Y.S.2d 550, 551-52; City Check
Cashing, Inc. v. Jul-Ame Constr. Co., 742 A.2d 141, 146
(N.J. A.D. 1999); nom. City Check Cashing Inc. v.
Manufacturers Hanover Trust Co., 764 A.2d 411 (N.J. 2001);
Knight Publishing Co. v. Chase Manhattan Bank, N.A., 479
S.E.2d 478, 486 (N.C. Ct. App. 1997); California Commercial
Code §4102(b); CAJUR BANKS (3d, 2009)
§190. 4 New
York UCC §1-201(4); California Commercial Code
§1201(4). 5 In
California, a check cashing service is not a bank, but is an
entity operating under a permit from the Department of
Justice and subject to regulation under Civ. Code
§§1789.30 et seq. 6 New
York UCC §1-105(1); California Commercial Code
§1105(1). 7 See,
e.g., Martin v. Julius Dierck Equip. Co., 52 A.D.2d 463,
468, 384 N.Y.S.2d 479, 483 (2d Dep’t 1976) 8 See
Hurtado v. Superior Court, 11 Cal. 3d 574, 579 (1974);
Washington Mutual Bank, FA v. Superior Court, 24 Cal. 4th
906, (2001); Kearney v. Salomon Smith Barney, Inc., 39 Cal.
4th 95, 100 (2006); Castro v. Budget Rent-A-Car System,
Inc., 154 Cal. App. 4th 1162, 1179 (2007), review denied,
(Nov. 28, 2007). 9 A
depositary bank means the first bank to which an item is
transferred for collection even though it may also be the
payor bank. New York UCC § 4-105(a); California
Commercial Code 4105(a). A collecting bank means any bank
handling the item for collection except the payor bank. New
York UCC § 4-105(d); California Commercial Code
4105(d). A payor bank means a bank by which an item is
payable as drawn or accepted. New York UCC § 4-105(b);
California Commercial Code 4105(b). A drawee bank is the
same as a payor bank. 10 See
J.M. Heinike Assocs., Inc. v. Liberty Nat’l Bank, 166
A.D.2d 922, 922, 560 N.Y.S.2d 720, 720-21 (4th Dep’t
1990); Board of Higher Educ. of the City of N.Y. v. Bankers
Trust Co., 86 Misc.2d 560, 564, 383 N.Y.S.2d 508, 511 (Sup.
Ct. N.Y. County 1976); Seaboard Finance Co. v. Miles &
Sons, 102 Cal.App.2d 526, 527-528 (1951); Seaboard Finance
Co. v. Miles & Sons, 102 Cal.App.2d 526, 527-528 (1951);
Karen Kane, Inc. v. Bank of America, 67 Cal. App. 4th 1192
(1998), as modified, (Dec. 1, 1998). 11
Id. 12
Horovitz v. Roadworks of Great Neck, Inc., 76 N.Y.2d 975,
975, 563 N.Y.S.2d 735, 735 (1990). In California there is no
judicial consensus on point. The leading trend seems to bar
a 1 13 New
York UCC § 3-305; California Commercial Code
§3305 14 New
York UCC § 3-302(1); California Commercial Code
§3302(1) 15 New
York UCC §§3-302(1)(b), 1-201(19); California
Commercial Code §§3302(1)(b), 1201(19) 16 First
City Federal Savings Bank v. Bhogaonker, 684 F. Supp. 793,
797 (S.D.N.Y. 1988); Howell v. Dowling, 52 Cal. App. 2d 487,
494 (1942) Witty v. Clinch, 207 Cal. 779 (1929). 17 See,
e.g., Chemical Bank of Rochester v. Haskell, 51 N.Y.2d 85,
92, 432 N.Y.S.2d 478, 480 (1980); Fundacion Museo de Arte
Contemporaneo de Caracas - Sofia Imber v. CBI-TDB Union
Bancaire Privee, 996 F. Supp. 277, 292 (S.D.N.Y. 1998);
Christian v. California Bank, 93 Cal. App. 2d 230, 232-233
(1949); Mann v. Leasko, 179 Cal. App. 2d 692, 697
(1960). 18 Banco
Di Roma v. Merchants Bank of N.Y., 251 A.D.2d 139, 139, 674
N.Y.S.2d 317, 317 (1st Dep’t 1998); Szczotka v. Idelson
228 Cal. App. 2d 399, 406-407 (1964) 19
Official Comm. 2 to New York UCC § 3-304; Official
Comm. 1 to California Commercial Code §3302 ; Hartford
Accident & Indem. Co. v American Express Co. 74 NY2d
153, 161, 544 NYS2d 573, 577 (1989). 20 New
York UCC § 3-404(a); California Commercial Code
§3404(b) and (c) 21 New
York UCC § 3-405; California Commercial Code
§3405 22
Prudential-Bache Securities, Inc. v. Citibank, N.A., 73
N.Y.2d 263, 270, 539 N.Y.S.2d 699, 703 (1989). No published
California case has interpreted the fictitious payee
rule. 23 Getty
Petroleum Corp. v. American Express Travel Related Servs.
Co., supra, 90 N.Y.2d 322, 330, 660 N.Y.S.2d 689,
694 24
Prudential-Bache Securities, Inc. v. Citibank, N.A., 73
N.Y.2d 263, 275, 539 N.Y.S.2d 699, 706 (1989) 25 New
York UCC § 3-406; California Commercial Code
§§3405, 3406 26
Horovitz v. Roadworks of Great Neck, Inc., supra, 76 N.Y.2d
at 975, 563 N.Y.S.2d at 735; accord, Prudential-Bache
Securities, Inc. v. Citibank, N.A., supra, 73 N.Y.2d 263 at
539 N.Y.S.2d at 704 27 Sun
‘n Sand, Inc. v. United Cal. Bank, 21 Cal. 3d 671
(1978) 28 See
Official Cmt. 2 to California Commercial Code §3417;
Mills v. U.S. Bank, 166 Cal. App. 4th 871, 883
(2008). 29
California Commercial Code §3403; Fireman’s Fund
Ins. Co. v. Security Pacific Nat’l Bank, 85 Cal. App.
3d 797, 804 (1978); Edward Fineman Co. v.Superior Court, 66
Cal. App. 4th 110 (1998) 30
California Commercial Code §3404(d) provides: “if
a person paying the instrument or taking it for value or for
collection fails to exercise ordinary care in paying or
taking the instrument and that failure contributes to loss
resulting from payment of the instrument, the person bearing
the loss may recover from the person failing to exercise
ordinary care to the extent the failure to exercise ordinary
care contributed to the loss.” 31
California Commercial Code §3405, emphasis
added. 32 Lee
Newman, M.D., Inc. v. Wells Fargo Bank, N.A., 87 Cal. App.
4th 73, 83 (2001) 33
Official Comment 4 to California Commercial Code §
3406 34
Error! Main Document Only.New York has not adopted the
revised Article 3 of the UCC, and has not enacted the scheme
of comparative negligence that Article 3 of
California’s UCC features. 35
California Commercial Code §3103(a)(7) 36 Id.
